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I found out about the inverted 3L-R pattern from an article in Traders.com (a printed magazine, not the website) and according to the author Paolo Pezzutti, it's based on the work
of Michael Harris.

The article suggests using a 7% profit target and 7% stop loss, which I tested. I also tested placing a stop at the other end of the pattern (for an downward breakout, for example,
it would be a penny above the pattern's highest high). One can infer that inverted 3L-R means the opposite of three lows and a reversal, which aptly describes the four-bar pattern
(three highs and a reversal).

Important Bull Market Results for Inverted 3L-R

The above numbers are based on hundreds of perfect trades as of 2/26/2013. See the glossary for definitions.

* Based on the trend low, not the ultimate low. See text.

** Based on the average drop compared to other small patterns with downward breakouts in a bull market

Inverted 3L-R Identification Guidelines

Characteristic

Discussion

4 bars

The pattern is composed of four bars, three highs and a reversal bar.

Higher highs

Look for two consecutively higher highs (using 3 bars) on the daily chart. It doesn't matter what the low prices of these bars look like, only that
each high is consecutively higher than the prior high.

Lower low

The last bar in the pattern has a low that is below the first bar in the pattern. It doesn't matter at what price the high is on this bar.

Inverted 3L-R Trading Tips

Trading Tactic

Explanation

Reversal

The pattern acts as a reversal pattern 52% of the time. In other words, the direction after the pattern completes is about random.

Trade continuations

Inverted 3L-Rs acting as continuations outperform those acting as reversals of the short-term trend. That means look for price to drop leading
into the inverted 3L-R (drops averaged 7% (continuations) versus 6% for reversals). The trend was the same in bear markets (14% versus 13%, respectively).

Short

Short at the open the day after the last bar in the pattern.

Measure rule

The Inverted 3L-R fulfills the measure rule 45% of the time (bull market). That is, measure the height of the pattern and subtract it from the low price to get a
downward target.

Inverted 3L-R Performance Statistics

For the following statistics, I used 1,243 stocks, starting from December 1989 to February 2013, but few stocks covered the entire range. All stocks had a minimum price of $5.
Since samples were so numerous, I chose one of every four patterns.
There were two bear markets in the 2000s (as determined by the S&P 500 index), from 3/24/2000 to 10/10/2002 and 10/12/2007 to 3/6/2009.
Everything outside of those dates represents a bull market.

For each inverted 3L-R, I found where the trend started and when it ended. To find the trend peak or valley, I found the lowest valley and highest peak within plus or minus 10 days
(21 days total) each, before the inverted 3L-R and the same peak/valley test after the inverted 3L-R. The closest valley or peak before the inverted 3L-R
is where the trend began. The closest peak or valley after the inverted 3L-R is where the trend ended. I compared the peak or valley to the average of the highest high and lowest
low price of the inverted 3L-R pattern.

The 10-bar peak or valley number tends to find major turning points on the daily charts.

I measured performance from the day after the pattern ended to the nearest trend peak or trend valley.

Inverted 3L-R Performance and Failure Rates

Table 1: Performance and Failure Rates

Market

5% Failure

Average Drop

Bull

46%

6%

Bear

29%

14%

Table 1 lists the failure rates, sorted by market condition along with the average drop. Since the inverted 3L-R is supposed
to act as a reversal of the upward trend, I assumed a downward breakout (downward move).

A failure occurs when the stock fails to drop more than 5%.

The failure rates may appear high, but that's typical for short-term patterns like the inverted 3L-R. The highest failures occur in a bull market: 46% fail
to drop at least 5%. The average drop is just 6%.

Inverted 3L-R Measure Rule

Table 2: Measure Rule Performance

Market

Success

Bull

45%

Bear

53%

Table 2 shows how often the measure rule works. Use the measure rule to find an estimate of how far price is likely to drop.

To do this, measure from the highest high to the lowest low in the pattern to get the height. Subtract the height from the lowest low to get the target.

The best performance of the measure rule occurs in a bear market, with 53% of patterns reaching their target.

Inverted 3L-R Trading Performance

Table 3: Testing the Inverted 3L-R

Market

Bull

Bear

Net profit/loss

$(72.32)

$52.46

Wins

44%

52%

Winning trades

7,538

2,565

Average gain of winners

$744.42

$759.37

Losses

56%

48%

Losing trades

9,757

2,343

Average loss

($703.31)

($721.43)

Average hold time (calendar days)

25

14

Table 3 shows the performance based on 22,203 trades using $10 commissions per trade ($20 round trip), starting with $10,000 per trade. No adjustments were made for interest,
fees, slippage and so on.

The results are sorted by bull or bear market. The trades used the same setup as listed in Inverted 3L-R Performance Statistics.
This test sold short a stock at the open the day after the pattern completed. If the opening price
was unavailable (many from the 1990s were 0), then I assumed a penny below the bottom of the pattern as the entry price.

A position was covered if the stock dropped at least 7% below the entry price. Again, if the opening price was lower than the target price, I used the open otherwise
I used the target price. A stop was placed 7% above the entry price.

For example, in a bull market, the net loss was $72.32 for all trades. The method won 44% of the time and there were 7,538 winning
trades. The average gain of winning trades was $744.42.

Fifty-six percent, or 9,757 trades were losers. They lost an average of $703.31.

The average hold time was 25 calendar days.

Notice how the gains and losses were pegged near 7%, which is how the test was setup.

Inverted 3L-R Trading Performance With Pattern Stop

Table 4: Testing the Inverted 3L-R with Pattern Stop

Market

Bull

Bear

Net profit/loss

$(22.17)

$39.84

Wins

34%

47%

Winning trades

5,903

2,295

Average gain of winners

$722.89

$744.64

Losses

66%

53%

Losing trades

11,433

2,614

Average loss

($406.85)

($578.95)

Average hold time (calendar days)

13

9

Table 4 shows the results of 22,246 trades, but this time, a penny above the top of the inverted 3L-R pattern was used as a stop instead of a 7% stop.

For example, in a bull market the net loss was $22.17 for all trades. The method won 34% of the time and there were 5,903 winning
trades. The average gain of winning trades was $722.89.

Sixty-six percent, or 11,433 trades were losers. They lost an average of $406.85.

The average hold time was 13 calendar days.

When compared to the 7% stop method, placing a stop above the top of the pattern showed that losses dropped substantially, especially in a bull market.
However, the win/loss ratio suffered and that impacted the net gain.

Inverted 3L-R Trading Example

The figure shows an inverted 3L-R pattern in 3M (MMM) on the daily scale.

The Inverted 3L-R looks like the inset with three higher highs followed by a low below the first low in the inverted 3L-R.

The four bar pattern ends the day before A. Sell short at the open at A, which is at a price of $91.92. The target is 7% below this, or $85.49.

The stock drops and hits the sell target as shown in the chart, at B.

A stop is placed 7% above the open, or 98.35 (not shown).

If the pattern stop method were used, the red line at C, which is a penny above the top of the inverted 3L-R, would serve as the stop location.